Taking Stock

No one seems to know whether we are now heading into a recession or are already in one. But for good reason the economy has become the dominant issue in the presidential campaign.

In Washington, both Congress and the Federal Reserve have taken steps to forestall an economic slowdown and to restore confidence in a battered financial system. That job will be daunting enough, but while we’re at it we should also ask how we got here and where we’re going. The U.S. economy, despite the president’s repeated reassurances, faces deep structural challenges. The collapse of the subprime mortgage market has led to foreclosures and to a dramatic downturn in the construction sector while undermining the rest of the financial system. This failure can be traced in part to the late-1990s deregulation of the banking and financial-services industries, which gave rise to new financial “instruments” that rewarded banks and traders for taking unreasonable risks. The IOUs for these arcane practices, such as bundling risky mortgages in to securities, are now coming due. Banks, financial institutions, and securities insurers are all paying the price in write-downs while desperately looking for bailouts from governments both domestic and foreign. Some experts estimate that asset losses will total $1 trillion.

While Washington and Wall Street are trying to limit the damage, it will take years for the U.S. housing, home-mortgage, banking, and insurance industries to recover. In the meantime, liquidity and credit are drying up, even for sound businesses. The “ATM mentality,” fostered by the housing bubble that allowed homeowners to borrow profligately against their inflated property values, has helped to create not only a nation of debt (the president’s recent budget proposal projects a $408 billion deficit in 2008, while the national debt nears $10 trillion), but also a nation of debtors (credit-card debt reached a record high last year, and Americans now pay on average 14.6 percent of their disposable income for debt service alone). While the Federal Reserve’s action to lower interest rates may rescue some home mortgages and free up credit, and while the recent congressional stimulus package may jump-start the economy temporarily, neither is likely to assuage the trauma many families are experiencing, or address the underlying crisis in confidence in our economic and financial system.

Historically, the U.S. economy has had many advantages: a government of laws and a well-regulated banking industry and securities market; the creativity of entrepreneurs; the availability of cheap energy, land, and natural resources; a strong manufacturing and exporting sector; affordable health care; a viable infrastructure and a well-educated populace; a respected military; and a strong dollar. Economically, the United States set the pace for the world in the second half of the twentieth century. But that was then. Today we face challenges in each of these areas, and four have particular relevance for our economic prospects.

First, manufacturing: America no longer makes what the world takes. In fact, it is largely the opposite. As Kevin Phillips notes in his forthcoming Bad Money (Viking), the United States has exchanged a manufacturing economy for a service economy, one that offers financial, banking, educational, and technical products. Second, the globalized financial system is fiendishly complex, and some argue it is more vulnerable precisely because of its integration, sophistication, and size. Third, our economy, if not our civilization, is based on one commodity: oil. But the world’s oil supply is limited, even as demand is rising worldwide. The price at the pump and this month’s heating bill reflect that reality and foreshadow what’s to come. As King Abdullah of Saudi Arabia warned last year, “The oil boom is over and will not return. All of us must get used to a different lifestyle.”

Finally, the once-mighty dollar is in a tailspin. For decades, the greenback was welcomed by nations eager to sell their cheap goods abroad. At the same time, oil-producing countries pegged their product to the dollar. In recent months, the dollar’s fall against other currencies has led exporting countries to diversify their holdings into other currencies, and to charge more dollars for their goods and oil. This adds to U.S. indebtedness and further weakens the dollar.

In the long run, the answers to our growing economic emergency will come from a better-regulated financial industry, fiscal accountability in Washington, business innovation, and new strategies for learning how to do more with less—perhaps much less. We must invest in mass transportation, energy conservation, and our depleted water resources. Yet the way forward is not merely a matter of developing greater efficiency or workplace productivity. Individually and collectively, we must rediscover the need for both economic and environmental sustainability. Living within one’s means used to be an American virtue.